Late last year, the Federal Housing Finance Agency (FHFA) formally adopted a regulation proposed by former Director Mark Calabria that raised Fannie Mae and Freddie Mac’s required capital by more than 80 percent compared with what would have been in effect under the FHFA standard proposed in June of 2018. Soon afterwards, this new capital rule was incorporated into a January 14, 2021 letter agreement between Calabria and former Treasury Secretary Steven Mnuchin, stipulating that before the companies could be eligible for release from conservatorship under a consent decree they would need to hold core (or tier 1) capital of at least 3 percent of their adjusted total assets—at June 30, 2021, about $230 billion—for two or more consecutive quarters. And then this June, the controversial ruling by the Supreme Court that the net worth sweep was a legal action by FHFA allowed Treasury’s $195 billion in senior preferred stock in the companies to remain outstanding. Because Treasury’s senior preferred is not considered core capital under the Housing and Economic Recovery Act (HERA), this put Fannie and Freddie’s combined core capital at June 30, 2021 at a negative $134 billion—more than $360 billion below the threshold for their conditional release from conservatorship under the Calabria-Mnuchin agreement.
Together, these developments left Fannie and Freddie in an impossible position. Their capital problem is obvious. With the net worth sweep blocking their access to the equity markets, it would take them nearly two decades to retain the earnings they need to fill a $360 billion capital gap, and longer if their business grows during that time. Less obvious, but no less serious, is their business problem. For the very long time they would remain in conservatorship, they would have no alternative but to price their credit guarantees to capital requirements that are grossly disproportionate to their credit risk, greatly raising the cost of and restricting the access to homeownership for the low- moderate- and middle-income homebuyers they are chartered to serve.
Fannie and Freddie’s situation is the result of a lengthy sequence of events that began with the decision in the last year of the Bush administration to force them into conservatorship, against their will and while each exceeded its statutory capital requirement, for policy reasons but under the pretense of a rescue. Throughout the Obama administration and for much of the Trump administration, FHFA and Treasury managed Fannie and Freddie in conservatorship in a manner intended to encourage Congress to replace them legislatively with a “free market” alternative—crippling the companies financially by forcing them to take $187 billion in non-repayable Treasury senior preferred stock at a 10 percent after-tax annual dividend that they did not request and did not need, falsely blaming them for the financial crisis, and burdening them with “bank-like” capital requirements unrelated to the risks of the one business they are permitted to engage in. There now is a consensus that replacing Fannie and Freddie with a free-market alternative that exists in theory but not in practice is neither achievable nor desirable. Yet the companies remain entangled in the consequences of past actions and fictions aimed at accomplishing that objective.
It has fallen to the senior economic officials of the Biden administration to sort this out. Fannie and Freddie are the cornerstones of the $13.6 trillion U.S. residential mortgage market. They have been successfully “conserved,” but because of decisions made in prior administrations—whose objectives the current administration does not share—they are locked indefinitely in conservatorship, and unable to help the president meet his housing policy objectives. There is, however, a simple way for the Biden administration to end the companies’ state of limbo: acknowledge the facts about Fannie and Freddie, admit that their de facto nationalization in 2008 was unjustified and a mistake, and then undo it.
The “undoing” can be achieved through two complementary actions. First, declare that Fannie and Freddie have paid back all of the $187 billion they were forced to draw during the crisis, including 10 percent interest (which they have done), and deem Treasury’s senior preferred stock to have been repaid and cancel it, along with Treasury’s liquidation preference. This would change Fannie and Freddie’s core capital at June 30, 2021 from a negative $134 billion to a positive $60 billion. Then, appoint a new Director of FHFA, and task him or her with replacing the Calabria capital rule with one based on the companies’ actual business and credit risks. As depicted and discussed in the sections below—which draw on publicly available past and current data from Fannie—there is a huge difference between the capital required by a risk-based standard for Fannie and Freddie based on fact, and one based on fictions invented by those who oppose the companies on ideological or competitive grounds. And, as we also will see, developing and implementing a fact-based capital rule for the companies is astonishingly easy.
Capital fact
Thirteen years after the Great Financial Crisis began, we know how much initial capital Fannie would have required to cover the credit losses of the $2.531 trillion book of single-family business at December 31, 2007 that went through it. There are two ways this “stress capital” amount can be expressed: for the liquidating book, and on a going concern basis. The former tracks credit losses on the 2007 book over its entire life, and uses as offsets to credit losses only guaranty fee income, net of administrative expenses, from loans in this book that do not prepay. In contrast, the going-concern method incorporates income (and losses) from new business, and runs only until annual total net guaranty fees, from both existing and new business, exceed annual total credit losses, and profitability is restored.
Fannie’s published data make it possible to track the losses on its December 2007 book of single-family business with precision through 2016, and to make very close estimates in the years beyond that. Through December 31, 2012—just before Fannie’s total annual guaranty fees exceeded its annual credit losses as a going concern in 2013—the losses on its 2007 single-family book were $70.0 billion, or 2.77 percent of the December 31, 2007 book. Those losses rose to $91.2 billion at December 31, 2020, for an ever-to-date credit loss rate of 3.60 percent. (Losses from the 2007 book since then have been de minimis.)
We also can use published data to make a conservative approximation of the amount of these losses that were absorbed by guaranty fees. The average guaranty fee rate on Fannie’s December 2007 single-family book was 24.2 basis points, which after 8.0 basis points in administrative expenses left a net guaranty fee of 16.2 basis points. The 2007 book prepaid at a 19.9 percent annual rate through the end of 2012, and at an overall annual rate of 20.9 percent through the end of 2020. From past experience, we know that lower-risk, lower-fee business prepays faster than higher-risk, higher-fee business, so assuming that the average guaranty fee on Fannie’s 2007 book stayed level over time produces a conservative (that is, low) estimate of cumulative guaranty fee income of $14.7 billion through 2012, and $19.3 billion through 2020. For Fannie’s liquidating book, $19.3 billion in net guaranty fees would have absorbed 76 basis points of its 360 basis points of ever-to-to date credit losses, leaving 284 basis points to be covered by initial capital.
On a going-concern basis, the initial capital requirement for Fannie’s 2007 book is almost 100 basis points lower, because it only has to cover stress credit losses until 2013, when its net guaranty fees of $7.2 billion exceed its total single-family credit losses of $4.5 billion (and then continue to), and because some losses can be absorbed by revenues from new business. As a going concern, the relevant numbers for Fannie’s 2007 book of single-family business during the stress years of 2008-2012 are: credit losses from the original 2007 book of $70.0 billion; credit losses from business done after 2007 (principally from the 2008 book) of $5.6 billion; net guaranty fees from the 2007 book of $14.7 billion, and net guaranty fees from post-2007 new business of $13.0 billion. Together, these result in total credit losses of $75.6 billion, total net guaranty fees of $27.7 billion, and losses that need to be covered by initial capital of $47.9 billion—equal to 189 basis points of the $2.531 trillion in single-family mortgages Fannie owned or guaranteed at December 31, 2007.
But the story does not end there. Since 2007, the credit quality of the company’s single-family business has improved markedly, and its net guaranty fee has more than doubled. The credit quality increase came about because of the sweeping changes in residential mortgage underwriting standards since the crisis, many mandated by the 2010 Dodd-Frank legislation. Data put out by Fannie indicate that between 50 and 55 percent of the credit losses on its 2007 book were from Alt-A or interest-only loans, now prohibited by Dodd-Frank. Taking just these two loan types (about $425 billion) and their associated losses (about $48 billion) out of Fannie’s 2007 single-family book lowers its lifetime credit loss rate from 360 to 205 basis points. And incorporating all underwriting improvements since 2007 lowers the loss rate still further. In its 2018 capital proposal, FHFA stated that “using current acquisition criteria” the credit loss rate on Fannie’s 2007 book of business through September 2017 would have been just 1.5 percent. Meanwhile, on the revenue side, the 16.2 basis-point average net single-family guaranty fee on Fannie’s December 2007 book has risen by 21 basis points, to 37.2 basis points at June 30, 2021.
Cutting the stress credit loss rate by over half and more than doubling the net guaranty fee have a dramatic effect on the amount of capital Fannie’s single-family book would require to survive a repeat of the Great Financial Crisis home price collapse. FHFA’s loss rate of 150 basis points through September 2017 for Fannie’s 2007 liquidating book “using current underwriting criteria” projects to 160 basis points of losses through December 2020. A net guaranty fee rate of 37.2 basis points, with prepayment rates equal to those of the 2007 book, would have produced 165 basis points of guaranty fee income during that time—5 basis points more than the credit losses. And the more conservative estimate of 205 basis points of losses from the current book’s underwriting (adjusting only for its lack of Alt-A and interest-only mortgages) still would have required Fannie’s 2007 liquidating book to have had only 40 basis points of initial capital to survive the Great Financial Crisis.
On a going-concern basis, today’s underwriting and net guaranty fee produce equally striking stress results, even using the 205 basis-point loss estimate for the current book, and assuming that both the size of the book and average guaranty fee remain level, rather than increase by 12 and 17 percent, respectively, as they did between 2007 and 2012. A net guaranty fee of 37.2 basis points on a level $2.531 trillion book of business produces $9.42 billion of revenue per year. Using the same pattern of credit losses as Fannie actually experienced between 2007 and 2020, a 205 basis-point cumulative loss rate through 2020 results in total single-family credit losses (from old and new business) that start at $3.69 billion in 2008, rise to $13.66 billion in 2010, and fall to $8.73 billion in 2012. At a constant $9.42 billion per year, cumulative guaranty fee revenues exceed cumulative credit losses by $6.69 billion during 2008 and 2009. Revenues fall short of credit losses by $6.33 billion in 2010 and 2011, but then are greater than credit losses again in 2012 and beyond. At no time during the stress period do cumulative losses ever exceed cumulative revenues.
The reality, therefore, is that based on Fannie’s historical experience, and incorporating its current single-family net guaranty fee and a conservative estimate of the credit quality of its current single-family book of business, the company as a going concern could survive a repeat of the 25 percent drop in nationwide home prices that characterized the Great Financial Crisis—on which the HERA risk-based capital standard is supposed to be based—without the need for any initial capital. Further, FHFA effectively confirmed this last month, when, with virtually no publicity, it released the results of the 2020 and 2021 Dodd-Frank “severely adverse” stress tests, run on Fannie’s business for the end of 2019 and 2020. The company needed no initial capital to survive those either.
Capital fiction
How, then, did former FHFA director Calabria arrive at the requirement that in order to meet his standard of safety and soundness at June 30, 2020, Fannie must have capital equal to 4.55 percent of its $3.761 trillion in total assets, or $171 billion? The short answer is that he concocted it. He ignored the directive in HERA to base Fannie and Freddie’s capital on risk, and instead began with a pre-determination to require them to hold at least the 4.0 percent minimum capital as banks hold for their on-balance sheet residential mortgages, on which they take interest rate as well as credit risk. He then used four contrivances—not counting guaranty fees in the risk-based capital stress test; subjecting low-risk loans to a minimum risk weight; misapplying the going-concern buffer, and adding a capital penalty for doing more than a small amount of credit guaranty business—to artificially engineer a result for the required amount of Fannie’s “risk-based” capital that was greater than his arbitrary minimum of 4.0 percent. Reviewing each of these briefly:
Guaranty fee income in stress tests. Fannie and Freddie are not banks; their one permitted line of business is guaranteeing the credit of residential mortgages. For a credit guarantor, the role of capital is to absorb losses that exceed the dollar amount of revenues from loans that continue to pay throughout a period of stress. This capital amount is determined by running a stress test—in Fannie’s case, one based on a 25 percent nationwide decline in home prices. Not counting any revenues during that stress test produces a meaningless answer. The Federal Reserve counts income in the Dodd-Frank stress tests it runs for large systemically important banks, and FHFA counts income in the Dodd-Frank stress tests it runs for Fannie and Freddie. FHFA’s 2018 capital rule, issued under Director Watt, did not count revenues either, and almost all commenters on that rule said that it should. FHFA calls not counting guaranty fee income in the stress test “conservative,” but it is far more than that. Conservatism in running a stress test would be increasing the prepayment rate on surviving mortgages from the 20.9 percent annual rate experienced by Fannie’s 2007 book of business to some higher annual percentage; setting it at 100 percent (which is what not counting guaranty fees at all does) is indefensible, and invalidates the result.
Net credit risk capital. In its June 2018 capital proposal, FHFA said that using the product and risk characteristics of Fannie’s September 30, 2017 book of business, the ever-to-date credit losses from Fannie’s 2007 book would have been 1.5 percent. This translates to a lifetime loss rate in the 1.65 percent range. The grids, risk multipliers and counterparty “haircuts” used in the 2018 FHFA capital rule pushed this net credit risk capital up to 2.1 percent of total assets. Calabria wanted an even higher number, however, so he put a 20 percent risk weight, or a 1.6 percent capital floor, on all mortgages, which made the net credit risk capital requirement on Fannie’s June 30, 2020 book—whose credit quality was at least as good as the September 30, 2017 book—289 basis points of total assets, or about 125 basis points more than the actual expected lifetime stress losses of that book.
Going concern capital. FHFA’s June 2018 capital rule included a “going concern buffer” of 75 basis points of capital, to “to ensure that each Enterprise would continue to be regarded as a viable going concern by creditors and other counterparties after a severe economic downturn.” Calabria’s 2020 capital rule renamed this the “stress capital buffer,” but kept it at 75 basis points. Both versions of the rule, however, conveniently ignore the facts that Fannie’s risk-based capital requirement is based on a liquidating book of business, and that shifting to a going-concern perspective results in the company having a large amount of loss-absorbing revenue from new business, and also a shorter stress period. During and after the Great Financial Crisis, Fannie needed almost 100 basis points less initial capital to survive as a going concern than it did to cover the losses on its liquidating 2007 book. Put differently, because Fannie’s risk-based capital requirement is (very conservatively) based on a liquidating book of business, it already has a going-concern buffer built into it.
Stability buffer. What Calabria calls the “stability buffer” of 110 basis points of total assets added to Fannie’s June 30, 2020 risk-based capital requirement is unrelated to risk, totally arbitrary, and based on a mischaracterization of Fannie and Freddie’s market share. They are the only two companies whose sole business is guaranteeing the credit of conventional (non-government-guaranteed) residential mortgages. Expressing their size as a percentage of the business done by entities which can originate, service or hold mortgages in portfolio, and then requiring Fannie and Freddie to hold more capital the further the volumes of their credit guarantees rise above a tiny 5 percent share of activities they are not permitted to engage in, is preposterous, and a blatant and clumsy means of penalizing their conventional credit guaranty function in favor of portfolio investing, which demonstrably is far riskier. The stability buffer has no place in the companies’ risk-based capital standard.
* * *
On the day Mark Calabria stepped down as Director of FHFA (at the request of President Biden), he said, “When the housing markets experience a significant downturn, Fannie Mae and Freddie Mac will fail at their current capital levels.” He had to know this was untrue as he was saying it; he had been sitting on the unpublished results of the 2020 stress test run on Fannie, showing that it could survive the Federal Reserve’s “severely adverse scenario” of a 4 percent drop in real GDP and a 4 percent rise in unemployment with no need to draw on its capital, now $37.3 billion, at all. Yet he had used his position to mislead the public, and also to convince the Financial Stability Oversight Council to not just endorse his wholly contrived 4.55 percent risk-based capital requirement for Fannie, but to go beyond it, by saying in a joint statement with FHFA, “Risk-based capital and leverage ratio requirements materially less than those in the proposed rule would likely not adequately mitigate the potential stability risk posed by the Enterprises. Indeed, more capital might be necessary.”
This fictional approach to Fannie and Freddie’s capital has gone unchallenged since the beginning of the conservatorships. The Biden economic team must change that, and it can start by acknowledging and embracing the incontrovertible facts about the companies’ past and present credit risk, and instructing a new Director of FHFA to replace the Calabria capital standard with one that draws on those facts. The Calabria standard is not fixable. It was constructed to produce an artificial result, and has too many unrealistic elements that interact in ways that have unintended consequences, such as the refusal to count guaranty fees in the stress test, which pushes the large majority of the cost of that artifice onto the borrowers of affordable housing loans, who are the least able to bear it. Moreover, it is completely unnecessary to have a risk-based standard that is as mind-numbingly detailed and complex as the current one. FHFA can provide an unquestionably high level of taxpayer protection, and at the same time allow Fannie and Freddie to price their credit guarantees on an economic basis, with a far simpler and fully transparent approach to capital.
A rigorous and highly effective capital regime for Fannie and Freddie can be built with just three elements: (a) a true risk-based capital requirement based on a stress test run on each company’s book of business every quarter, with no cushions or add-ons; (b) a single “all purpose” capital cushion, calculated as a percentage of this true risk-based requirement, and (c) a minimum capital percentage. Fannie and Freddie’s required capital would be the greater of the risk-based amount (plus the capital cushion) and the minimum percentage. To implement this regime, FHFA only would need to decide on two numbers: the multiple to be applied to the stress test results (which will change each quarter, based on changes in the companies’ mix of business) that determines the size of the risk-based capital cushion, and the minimum capital percentage. And for each of these, there is one compelling choice.
As basic principles, the multiple FHFA should apply to the results of Fannie and Freddie’s quarterly stress tests should be large enough to provide meaningful protection against unanticipated events or model error in the stress test, but not so large as to override the true risk-based element, and distort the companies’ credit pricing. Thirty percent—or a 1.3 multiple—seems about as large as a capital cushion could be without violating the second principle. Also, in determining the size of the cushion, it is critical to bear in mind that the amount of capital Fannie and Freddie actually will hold—and that will serve as the basis for the pricing of their credit guarantees—will be more than the greater of the minimum or the risk-based standard. To avoid regulatory sanction, company management must meet both their minimum and risk-based standards. If they draw on their capital cushion, whatever its size, they will be subject to prompt corrective action. To avoid that, they invariably will hold excess capital, typically 10 to 20 percent of their required amount. During periods of stress they will first draw down that excess capital, then, if necessary, raise new equity.
For Fannie and Freddie’s minimum capital requirement, the clear choice is 2.5 percent, for three reasons. First, a 2.5 percent capital requirement for the companies’ on-balance sheet assets already is in HERA, as is a 45 basis-point requirement for their off-balance sheet credit guarantees (on which they take only credit risk). When the FASB required Fannie and Freddie to put credit guarantees on the balance sheet in 2010, FHFA sensibly kept their minimum capital at 45 basis points by regulation, since their economic substance hadn’t changed. If FHFA simply removes that regulatory waiver, the result will be to more than quintuple the required capital on credit guarantees relative to pre-crisis times—“serious reform” by any measure. Second, in FHFA’s June 2018 capital proposal, “2.5 percent of on-balance sheet assets and off-balance sheet guarantees” was the more conservative of the two alternatives for Fannie and Freddie’s minimum capital (the other was “1.5 percent of trust assets [MBS] and 4 percent of non-trust assets”). And third, 2.5 percent also is the minimum in the 2020 final Calabria standard—only without the (excessive and unjustified) “prescribed leverage buffer amount” of 1.5 percent, which brings his total to 4.0 percent.
Were this capital regime and minimum percentage to be adopted and implemented today, the 2.5 percent minimum would be far above Fannie and Freddie’s risk-based requirement, and thus be binding. At June 30, 2021, 2.5 percent of their total assets (not “adjusted total assets,” a concept FHFA should drop) was $175 billion. With the Biden administration at the same time deeming Fannie and Freddie’s senior preferred stock repaid and canceling Treasury’s liquidation preference, the companies’ core capital would rise to a positive $60 billion, leaving them with a gap to adequate capitalization of $115 billion.
Fannie and Freddie’s after-tax earnings over the past four years have averaged more than $20 billion per year. With only a $115 billion capital gap, a capital standard that permits them to price their credit guarantees fairly, and without the net worth sweep, the resulting strong investor demand for their equity would open up many paths out of conservatorship for the companies. One would be for FHFA, with Treasury approval, to set a new threshold for their release under a consent decree—say 1.5 percent of total assets—that would take effect upon settlement of an equity issue that meets or exceeds this threshold. Then, each company would be allowed to decide the mix of retained earnings, issues of common stock, or issues of noncumulative junior preferred stock to use to eliminate its remaining capital gap, and obtain its release from conservatorship unconditionally. Other alternatives for a quick exit from conservatorship undoubtedly would be proposed as well.
During previous administrations, following the fictions about Fannie and Freddie has led to their interminable conservatorships. To get them out, the Biden administration merely has to change course and follow the facts. When it does, all of the companies’ stakeholders—and particularly low- moderate- and middle-income homebuyers—will reap the benefits.
HOWARD ON MORTGAGE FINANCE 
The prepared remarks from Acting FHFA Director Thompson at today’s 2021 MBA Annual Convention and Expo.
The prepared remarks include below text:
“As a veteran of many financial crises, I can assure you that I have a strong appreciation for the importance of loss-absorbing capital at financial institutions. The Enterprises are now rebuilding their own capital to ensure that they have the resources to fulfill their mission to keep housing finance markets liquid, in both good times and bad.
We will continue to review capital adequacy and capital requirements at the Enterprises, and in doing so, we will be sure to promote transparency and good planning in the process.“
https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=Prepared-Remarks-of-Sandra-L-Thompson-Acting-Director-FHFA-at-the-2021-MBA-Annual-Convention-and-Expo.aspx
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I always worry when people with undistinguished job histories burnish their own reputations and then offer a bunch of feel-good generalities saying nothing.
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I read Acting Director Thompson’s prepared remarks at the MBA conference today. The combination of her statement about the importance of “robust regulatory capital” and her declaration that, because FHFA’s “analysis never stops,” it had found in its Enterprise Regulatory Capital Framework (ERCF) “two areas that warranted revision” was not encouraging. There is quite a lot more in the ERCF that “warrants attention,” as I explain in my comment to FHFA filed late this afternoon on the amendment it proposed on September 16. I’ll reproduce that comment on the blog as a post tomorrow morning.
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there is a new lawsuit filed in the court of federal claims challenging the conservatorship:
see http://www.glenbradford.com/wp-content/uploads/2021/10/21-cv-01949-0001.pdf
the individual plaintiff (a holding company with bank investors, that owns over $800MM in GSE stock) alleges direct and derivative claims. I imagine that having seen the conservatorship class action go through a motion to dismiss, this action may tweak its claims to insulate it from dismissal. the big issue is the threshold issue of the statute of limitations…which the complaint alleges has been tolled (stopped) for this action by the pre-existing class action case filed within the limitations period (of which the P is a class member). whether an individual class member can benefit from a class action’s tolling of the statute is a fine point of federal civil procedure that I cant handicap at the moment. if govt can successfully argue that the tolling of the statute by the other suit cannot be applied to this suit, then this suit is blown out of water.
the attorneys are Hagens Berman, which is also class action lawyers for the class action complaint. they are of course familiar with the facts and law relating to the new action, and perhaps with the denouement of Collins, the firm has a revived financial interest in the matter.
rolg
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I read the FBOP suit this morning, and had a similar reaction to the contention that the statute of limitations on this case had been tolled between the date the Washington Federal suit was filed in the Court of Federal Claims (June 10, 2013) and the date it was dismissed by that court (July 16, 2020). I’m not qualified to judge the legal merits of this assertion, however–although it does strike me as novel, and novel interpretations of the law generally face long odds of success–so I’ll wait to see how the Court rules on the government’s motion to dismiss, once the case gets to that point.
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Tim
I have not researched point, but if a class action is properly filed, thereby tolling S/L and then is dismissed on motion, then an individual P likely can pick up the claims anew (and amended) and piggyback on the S/L profile from the original action. Hagens Berman should know this off the top of their head, and I doubt it would invest resources in the new action without at least some confidence.
rolg
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If this is true (and I have no reason to doubt it), then it seems that the only beneficiaries of the suit would be the FBOP affiliates, to the tune of about $1 billion in damages.
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Tim
There is a derivative claim (p.34 and paragraph 122). it is not clear to me how this complaint differs (or improves upon) the claims that Hagens Berman brought in the original action. but again, the firm is high quality and typical pursues claims on contingency where it has to invest its own resources in anticipation of a lodestar recovery, so there’s some reason the firm brought this action that merits that investment.
rolg
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I’m out of my area of expertise on this, so I’ll just sit back and watch how it develops (with my seat belt buckled).
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An interesting development this morning from the 8th circuit.
“The Eighth Circuit says Judge Schiltz erred in dismissing the Bhatti Plaintiffs’ suit, it reversed the dismissal of plaintiffs’ separation-of-powers claim, and the appellate panel has remanded the case to the district court to determine if shareholders suffered compensable harm and are entitled to retrospective relief.”
http://www.glenbradford.com/2021/10/fnma-fanniegate-1077/
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@BB
I think there may be less than meets the eye here, but see below. Judge Schiltz will be a second federal district judge who will assess whether Ps suffered harm from Watt’s being in office for two years.
But there is this….I strongly object to the SCOTUS statement that the method of appointment was valid, when deMarco, the appointed acting officer stayed on for over 2 years longer than appropriate by virtue of the text of the constitution relating to acting officers. Why my objection? Because the appointment clause claim was not asserted in Collins!!! it was asserted only in Bhatti.
Whatever SCOTUS said about the appointment clause in Collins should NOT bind the 8th Circuit.
rolg
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Senator Toomey:
— https://www.banking.senate.gov/imo/media/doc/toomey_letter_to_yellen_on_reinstating_capital_requirements.pdf —
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A fact-free entreaty to Treasury from the ranking member of the Senate Banking Committee to keep Fannie and Freddie smothered in over-regulation and over-capitalization in the name of protecting taxpayers (at least two-thirds of whom also self-identify as “homeowners,” and in that capacity almost certainly do not share Senator Toomey’s concern.) Apparently nobody told the Senator about the results of the last two Dodd-Frank stress tests run on the companies’ books of business at the end of 2019 and 2020, showing they could survive a “severely adverse” scenario of either a 28 percent (on the 2019 books) or a 23.5 percent (on the 2020 books) decline in nationwide home prices with either no initial capital (Fannie for both years, and Freddie for its 2020 book) or only a minimal amount of capital (Freddie’s 2019 book). Far from taking too much credit risk, these stress tests show the companies are not taking enough.
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Tim, I find it very frustrating that no one, on either side of the aisle, calls this absolute knucklehead out (preferably directly to his face). It’s insane to me how the recent stress test results have not been discussed and highlighted more when a guy in position of power like that takes the liberty to put forth that letter. What the heck is the point of having them performed on the GSEs if we aren’t going to apply or take the results into consideration. IMO someone should be pounding the table hard, but it seems we hear about it for a day or so and then its ‘crickets’. Thanks for what you do, just a brief rant of frustration.
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Toomey’s last sentence: “I eagerly look forward to Treasury’s submission to Congress of the GSE recapitalization proposal contemplated by the January 2021 PSPA amendments.”
Ha! treasury is already late and there is no sighting on the horizon. It is hard to understand Toomey’s letter other than a missive from someone on his last lap around the sun as senator. One may expect Toomey to continue his GSE activity soon as a highly paid lobbyist…unless by this letter he has already jumped the gun….
rolg
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That letter should serve as a reminder to the current Administration that they face a choice. They can recap & release the GSEs with a sensible capital rule and otherwise positioned to serve their intended role. Or, they can let the next Republican Administration (and the next Calabria) eventually finish what Calabria started. Senator Toomey even cites the “limits on FHFA’s regulatory authority outside of conservatorship”, which seems like a key reason why the incentive to not hand the ball back to the next Republican Administration should be significant.
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The letter indeed highlights the ideology divide on what roles the GSEs should play in the housing finance market. Toomey clearly advocates limiting GSEs’ involvement by stating it is the choice of Obama who entered NWS. Well, the current administration sets forth a different path by removing some limits and reducing the capital requirements, which expands the GSEs role in the market. I completely agree that there is a big incentive for the administration to allow FnF to exit from conservatorship, if they don’t want the course to be reversed and the GSEs to be shackled again. In this case, the affordable housing mission is sort of on the line and so are taxpayers’ interests.
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Hot off the presses from one our fellow travelers!
Click to access Fannie_and_Freddie_-_what_happened_why_it_happened_and_how_to_fix_it_2.pdf
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This may be “hot,” but it’s not “hot off the presses.” Gary originally published this on September 1.
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Very slight differences but yes, in principle. 🙂
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Tim,
Where do we stand on IF and WHEN Michael Calhoun will, or will not, be nominated as FHFA Chief?
Is the budget, as well as everything else, currently sucking the oxygen out of the room in the same manner the Jan. 6th Events did?
VM
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Some person or group of people within the Biden administration seems to have understood what needs to be done at FHFA well enough to have gotten Mike Calhoun’s nomination to the starting gate, but the banking lobby got wind of it and held it up (at the very least; it’s possible they’ve derailed it). So now we’re back to the old fight, with the banks pulling out all the stops to keep Fannie and Freddie under their collective thumbs. I don’t know how strong the appetite is among the senior economic officials in the Biden administration to engage in this fight in the name of sensible economic policy and supporting affordable housing, but at the moment their full attention is devoted to the infrastructure bills in Congress and dealing with the debt limit. I wouldn’t venture to predict when the Fannie/Freddie issue will again become a focus of policymakers’ attention.
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This comment is an important reason as to why I think it makes so much sense for the administration to follow your original proposal and forgive the SPS and liq. preference prior to nominating a new FHFA director. I hope someone in the administration is paying attention (and cares enough to do it).
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Tim,
Curious about your thought on whether realizing the economic values in the stakes that Treasury holds would help to advance the infrastructure initiatives as a component of a solution, an alternative to certain tax increases, or even a bargain chip to win some senators’ support. Would it be appealing to the administration, or the housing finance policy is still such a big deal and they have to leave it alone for now.
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As of today, the economic value of Treasury’s warrants for 79.9 percent of Fannie and Freddie’s common stock is less than $6 billion ($5.94 billion). The $150 billion value figure that’s been thrown around for Treasury’s stakes in Fannie and Freddie would be reasonable, and perhaps even low, for two companies earning $20 billion after tax per year were they not mired in conservatorship, with all of their profits owed to Treasury (and the companies “allowed” to retain them, subject to an equal dollar increase in Treasury’s liquidation preference) and burdened by their regulator, FHFA, with non risk-based capital requirements they are more than $360 billion away from meeting. Until those problems are fixed, however–and as I discuss in the current post it’s not at all hard to do, if the administration has the will–the $150 billion value for Treasury’s warrants will remain theoretical.
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Tim
this $6B to $150B valuation delta is exactly the reason why owning, in effect, 100% of GSEs in conservatorship is worth so much less than 80% of the hugely profitable GSEs that can access the public equity capital markets. this is a great talking point that can be used for the Biden administration, especially considering that no cash flow is being directed to Treasury currently under the NWS. under the status quo, Treasury’s stake in the GSEs is perhaps the worst case of financial mismanagement and wealth destruction in financial history.
we have Calhoun who is a life long advocate of affordable housing who is on record as directing this $150B treasury stake towards affordable housing objectives, and who would play well in the capital markets as a regulator of GSEs qua utilities. then you have Thompson who…is on record for nothing during her 8 years as an FHFA bureaucrat. She went along to get along. This is not a difficult choice. Keeping Thompson as acting Director preserves a status quo of wealth minimization for Treasury. Stupid is as stupid does.
rolg
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Agree that these blocking issues have to be dealt with first, such as the current capital structures, legal issues and capital requirements, which the administration has complete control over. Hope that the administration can see the benefits of addressing the conservatorship issue at this point in history, and leverage wisely.
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Don Layton:
https://www.jchs.harvard.edu/blog/newly-proposed-changes-gse-capital-rule-will-eliminate-harmful-distortions —
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This is not a helpful piece from Layton, starting with its title: “Newly-proposed Changes to the GSE Capital Rule Will Eliminate Harmful Distortions.” They decidedly do NOT do that; all they do is give Fannie and Freddie a capital incentive to issue credit-risk transfer (CRT) securities. Layton is a huge fan of these, however, and he has allowed his enthusiasm about the CRT changes proposed by Acting Director Thompson to lead him to be rosy to the point of inaccuracy about what he says are the “three important policy implications that will flow directly from those changes.” He lists these as:
1. “The amount of capital required will be lower—not by much right now, but avoiding unduly large increases in the future.” After making this assertion, Layton doesn’t explain why the Thompson amendments will avoid “unduly large increases in the future” for the companies’ capital, and they won’t. The amendments don’t address or eliminate any of the four contrivances I discuss in my current post that cause Fannie’s risk-based capital requirement at June 30, 2020 to be 4.55 percent at a time when it requires zero capital to pass FHFA’s Dodd-Frank stress test, and they leave the pro-cyclical aspects of the Calabria standard intact, meaning that as home price growth slows both Fannie and Freddie’s required capital will rise from their already unreasonable and excessive levels.
2. “Decision-making at the GSEs can become less distorted, and more based on true economics and risk, resulting in better-run and more safe-and-sound companies.” This statement makes clear that Layton does not understand that the Calabria capital standard isn’t “based on true economics and risk” at all; it’s completely arbitrary and contrived. His discussion on this point makes it seem to the generalist reader that the Thompson amendments have done something to fix the distortions of the Calabria capital standard, and they have not.
3. “CRT transactions that are economically efficient can proceed full speed ahead.” Neither Layton nor FHFA have ever said how they define “economic efficiency” for a CRT transaction. All that’s happening here is that FHFA is allowing Fannie and Freddie to reduce their unjustifiably high capital requirements by spending money to issue CRTs that will transfer far fewer dollars in credit losses than the companies pay on CRT interest. That’s not “efficient.” Moreover, while FHFA’s CRT amendment may reduce the companies’ required risk-based capital, it will have very little effect on the guaranty fees Fannie and Freddie will have to charge: they will be able to lower their guaranty fees because of the reduced capital charge, but at the same time they will have to raise the fees by almost as much to cover the cost of interest payments on the CRTs which will be made with little likelihood of recovering any meaningful amount of credit losses (as FHFA’s own May 17, 2021 report on CRTs confirmed).
Overall, then, I view this piece as an unfortunate step backwards in the attempt to get policymakers to the right answer for what to do about Fannie and Freddie. It’s a problem when even the “good guys” aren’t being helpful to the cause, as is the case here.
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Sure is quiet here in Tim Howard land….no recent comments…is everyone holding their breath for some news?
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Treasury and FHFA were supposed to submit their plan to end the conservatorship. I sent a reminder:
https://mobile.twitter.com/GuidoPerei/status/1443617843640082449
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@gd
that clause in the “exit” letter agt was meaningless when written and will be meaningless when ignored by treasury and fhfa. organizational bandwidth within a new administration is constrained, for all administrations since running the country aint easy, but especially for this Biden administration which has put too much on its plate to eat clean, given its electoral “mandate”.
at some point after a few months we shall see if the biden administration revisits the GSEs…but I am not holding my breath…they just nominated a bank regulator (female/minority) who is anti-banks…wants to eliminate private banks and make the federal reserve bank the primary consumer deposit financial institution…the “peoples’ bank”. if ms waters isnt satisfied with this nomination and needs ms Thompson to fully fill out her bingo card, then GSE conservatorship will become eligible to vote (and drink).
rolg
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https://finance.yahoo.com/news/tim-howard-calls-capital-rule-131807165.html
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*
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The bank lobbyists are winning:
https://mobile.twitter.com/hannahdlang/status/1439972048844042243
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The bank lobbyists “won” when they convinced the FHFA bureaucracy that the right fix for the totally contrived Calabria capital rule was to make it a little less onerous by giving Fannie and Freddie higher capital credits for issuing more of the CRTs that Wall Street and the investment community love (and on which they all make money). Fannie and Freddie’s net income and retained earnings are reduced by the additional interest payments on the CRTs, but because FHFA drops their required capital by more than the present value of those interest payments, Fannie and Freddie have a strong economic incentive to issue the. CRTs. That almost certainly is why Fannie will restart its CRT program in the fourth quarter.
The banks win because the incredibly complex, non-risk-based, “bank-like” capital standard created by Calabria to grossly overcapitalize Fannie and Freddie stays in place, and FHFA can claim to have been responsive to the public demands to fix it. Of course, what FHFA “fixed” was the one feature of the Calabria standard Wall Street didn’t like–its treatment of CRTs. The multiple problematic features of the standard that raise costs for the affordable housing community remain untouched, and in my view are unlikely to be changed unless FHFA gets a new director who understands those problems and has the conviction and the political courage to take them on.
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Tim
“…because FHFA drops their required capital by more than the present value of those interest payments, Fannie and Freddie have a strong economic incentive to issue the CRTs.”
interesting, and I never considered this part of the incentive pie. now, I suppose by giving more capital credit to CRTs which reduces the overall required capital amount (albeit inefficiently), this should have some effect on reducing required g fees, but of course fixing the capital rule would have a more direct and substantial effect on reducing required g fee levels and promoting affordable housing.
what concerns me is that the Biden administration will now go to sleep on the GSEs if they think these bandaid changes have fixed what Calabria has wrought, and we will have Thompson as acting director (and conservatorship) until the cows come home. but if all of the search and vetting yielded Calhoun as the choice for director, you would think affordable housing would be enough of an issue to be fixed (or built back better) for there to be follow through once the headlines turn over a bit and Ms Waters moves on to a new cause celebre.
rolg
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Two points about Fannie and Freddie’s guaranty fees. First, and most importantly, the companies still are pricing to the Watt capital rule of 2018 (or what they call the “conservatorship capital standard.”) Fannie’s average charged fee on its new business in the second quarter of 2021 was 46.7 basis points. To earn a 10.0 percent after-tax return on its current “Calabria capital” of 4.55 percent, it would need to charge an average fee of 70 basis points. (If Fannie lowered its after-tax ROE to 9.0 percent, it “only” would need to charge an average of 64 basis points.) Nobody seems to have focused on this yet. Second, I suspect that the capital savings from CRT credits won’t be that much greater than the present value of the interest payments on the CRTs, so the negative (interest payment) and positive (capital credit) aspects of CRT issuance on guaranty fees likely will come close to offsetting.
Back to the first point, the fact that Fannie and Freddie aren’t yet pricing to the Calabria capital rule–but will need to begin doing so at some point–means that the adverse impact of the rule is not going to go unnoticed. And if the rule stays in place as is, even with the “Thompson amendments,” Fannie and Freddie’s required capital percentages will move higher as home price growth slows, because of the rule’s structural pro-cyclicality. I hope we don’t have to wait until these adverse consequences are upon us for the Biden team to act to mitigate them–they’re readily predictable, and the banks can’t “wish them away.”
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Tim
Why aren’t Fannie and Freddie pricing g fees according to the Calabria rule yet? I am confused (or is there some transitional period built in)?
rolg
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Fannie has been very quiet about its reaction to the Calabria capital rule.
As to the effective date of the rule, all Fannie said in its 2020 10K was, “The final rule goes into effect in February 2021, but the dates on which we must comply with the requirements of the capital framework are staggered and largely dependent on whether we remain in conservatorship.” That’s not very helpful. And on its guaranty fee pricing, here is what Fannie said in its second quarter 2021 10Q: “The guaranty fees we charge are based on the characteristics of the loans we acquire. We may adjust our guaranty fees in light of market conditions and to achieve return targets.” Not very helpful either.
I think Fannie is keeping its guaranty fees relatively unchanged (with the exception of the impact of the “adverse market fee,” which raised the effective fee on new business during the first and second quarters of this year, but will be dropped in the third quarter) for two reasons: (1) it knows it can’t raise fees too much further without losing significant amounts of business, and (2) it also knows what I laid out in my current post: the combination of the Supreme Court decision on the net worth sweep and the imposition of the Calabria capital rule has left it in an impossible position, and there is no sense in pretending they can get out of it on their own by boosting their guaranty fees to levels that are wildly excessive relative to the risks of the loans they are guaranteeing. It will be very interesting to see if FHFA requires Fannie to try to do that in any event.
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Unfortunately – i agree with your sentiment. If Thompson is left as the acting director or nominated as the director, we will have Mel Watt 2.0. She will hide behind Congress for a solution and as a good bureaucrat keep on with the CSHIP.
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Unfortunately, based on my experience working with regulators and other large bureaucracies, people don’t take action until something is clearly broken. Government is rarely if ever proactive. Although you see a clear problem with a predictable outcome, until Fannie and Freddie actually do price to the capital rule, you won’t see action. That will be the impetus for action unfortunately. At this point, even if staggered, it’s probably a good idea for the GSEs to start pricing to the new capital rule if for no reason than to make the problem evident.
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Tim, I wondered if you could share your thoughts on this: Amendments to the Enterprise Regulatory Capital Framework Rule – Prescribed Leverage Buffer Amount and Credit Risk Transfer
Click to access Fact-Sheet-Capital-NPR.pdf
Thank you
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I find it strange that this proposed rule is released just before the expected nomination of a new FHFA director. is FHFA’s current acting director seeking to preempt the new director?
rolg
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After all that’s happened in GSE-world, nothing surprises me about Fannie and Freddie.
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My reaction to this re-proposal is that it’s the FHFA bureaucracy, led by Sandra Thompson, saying, “We know former Director Calabria’s capital rule is very unpopular, but we can fix it. See?” With the implication, of course, that there is no need not to keep Ms. Thompson in place.
As to the “fix,” it’s what you’d expect the bureaucracy to do: take something that’s an absolute hairball, tweak it to get the number (as calculated today) down to a level you think most would say is “tough but fair,” and call that a victory. It’s better than nothing, but the fix would be only temporary. Remember, the true risk-based capital number using today’s book of business is around zero. But that’s because we’ve had an unprecedented run of home price appreciation. If you take the Calabria Rube Goldberg machine, tweak it so that it produces answer of around 3.0 percent capital today, when the home price environment becomes less favorable you’ll get a (considerably) higher number, which still won’t be risk-based; it will be an artifact of the interplay of the rule’s arbitrary assumptions and exclusions.
I’ll comment on the amendments to the rule, in specifics, but my bottom line is that FHFA needs to do a much more thorough overhaul than this for the rule to be something Fannie and Freddie can build a business on, and investors can confidently invest in. I think that Mike Calhoun recognizes this and would be much more inclined to scrap the Calabria rule. That’s why I hope he’s nominated–and it’s also why the Financial Establishment is holding up his nomination, and I think is trying to kill it.
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It also doesn’t address the pro cyclical nature of the rule and is again promoting the failed experiment of CRTs. That used to be a theoretical failure, but it is now a real failure. I can’t believe how soon they want to repeat it.
On the bright side, this is just a proposed rule. It likely will not be finalized by the acting director. If Calhoun is confirmed, he will have the choice of re-proposing a new rule, or making adjustments to this proposed rule based on his knowledge and comments received. Your comments will be important to getting it right. Starting the rule making process now could help expedite finishing it quickly after confirmation.
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Pro-cyclicality is one of many structural problems with the Calabria rule, which is why it can’t be fixed by the sort of “tweaking” Ms. Thompson is proposing. I’ll try to explain this in understandable (and I hope convincing) language in the comment letter I intend to file.
I am not against credit-risk transfer (CRT) securities in principle; I’m simply against making them mandatory. I believe it should be up to each company to decide to issue them or not. In the past, FHFA set targets for what percentage of a certain group of new mortgage acquisitions it wanted Fannie and Freddie to cover with CRTs. While technically not a mandate, there were executive compensation consequences for not hitting the targets. I hope FHFA drops those in the future.
It appears that FHFA will (again) be reviewing how much capital credit to give for CRTs. Wall Street (and the Financial Establishment in general) is in favor of a very generous credit, because CRTs are very profitable for investors to own (very attractive yields and very low chance of credit loss) and Wall Street firms to issue and trade. The game that’s being played is that FHFA throws extra conservatism into the capital rule, then allows the company to eliminate some of the capital requirement created by that conservatism by issuing CRTs. It sounds harmless, but of course it’s not: somebody has to pay for this give-away to the investment community–in the form of interest payments paid by Fannie and Freddie to CRT investors in return for very little credit loss transfer coming back–and it’s the homebuyer. A homebuyer subsidy to Wall Street and the investment community is not ideal public policy, but I don’t see many if any in the Biden administration trying to stop that train.
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Tim
I have always viewed CRTs as a conservatorship-based activity…the GSEs couldn’t build up equity capital with NWS, so CRTs were a necessary second-best means to absorb capital risk. If the new FHFA director is seeking to promote conservatorship release, perhaps any CRT usage can be premised on occurring only during conservatorship, unless post-conservatorship CRT pricing substantially improves over what is available now. I wonder if I am being cynical in believing that the acting director betrays a certain allegiance to a continued conservatorship status for the GSEs now that has put out this CRT capital rule amendment.
rolg
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Stevens wants Thompson to be the permanent FHFA director. How is it possible that progressives don’t want Calhoun because of his Wall Street ties (whatever that means), yet they are ok with Thompson who is giving away credit risk transfers to Wall Street? How is Stevens able to slide as a progressive now after working for Wells Fargo and MBA? Is anyone bringing this up to the Administration?
https://www.housingwire.com/articles/sandra-thompson-should-be-the-permanent-fhfa-director/
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alecmazo – Just because Gasparino calls Stevens and DeMarco progressives, doesn’t make them progressives. Nor can he make me a hedge fund.
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Dave Stevens and the other bankistas don’t want Mike Calhoun as FHFA Director because Calhoun will want Fannie and Freddie to be less over-regulated and overcapitalized so they can be more effective in supporting affordable housing (as they were chartered to do). Stevens and his fellow travelers know that Thompson is much less likely to rock the status quo boat–she’ll play within the lines they’ve drawn–so she’s their candidate. They (the bankistas) have succeeded in delaying what was supposed to have been Calhoun’s announcement this week as Director-designate, but hopefully that’s only a delay, not a derailment. But we shall see.
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Waters urges Biden to nominate FHFA’s Thompson as agency’s director.
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Ed DeMarco, then FHFA Director, hired Thompson in 2013.
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My question for her is where was she and what did she do when her boss was creating his regulatory monster??
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Tim
Some final thoughts on the implied covenant of good faith and fair dealing:
https://ruleoflawguy.substack.com/p/final-thoughts-on-the-implied-covenant
rolg
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Tim,
I suspect you might be pleasantly surprised at the news today by FHFA/UST. https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-and-Treasury-Suspending-Certain-Portions-of-the-2021-Preferred-Stock-Purchase-Agreements.aspx
Specifically, “FHFA is reviewing the Enterprise Regulatory Capital Framework and expects to announce further action in the near future.” (ideally to re-work it to a more appropriate level as discussed in your post)
Additionally, they agreed to suspend certain changes made by Calabria to shrink the GSEs footprints as well as to allow the GSEs to continue to build capital.
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Both steps in the right direction. It’s clear that someone in the administration understands that what Calabria did with the capital rule and the business restrictions in the January 14 letter agreement with Treasury were neither justified nor good for the mortgage and housing markets.
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I wonder if a new proposed capital rule will get printed? Would be good to get that ball rolling now so a confirmed director can finalize it right away.
Can they also make minor tweaks or “clarifications” to the rule while going through the public comment period?
Cheers,
Justin
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Tim – In terms of the current cap rule I contend that there is a possibility that it can be cancelled – almost immediately by Final Notice with no comment period. The issue is what it would revert to. However, given that amount of time that the new Director would need to turn the ship around, the ability to incorporate enforceable changes that can implement some of the housing goals of the Biden administration without legislation and the opportunity to solicit (and really, really consider this time) comments from all stakeholders, I don’t think there should be a panic like sense of urgency to publish a new Rule. I am not saying sit on this for an excessive amount of time, as Calabria appeared to do, but publish a draft as soon as possible and allow a reasonable amount of time, such as 120 days for responses. But I think the most important point concerning the Cap Rule is that, although you want something that will last for a relatively long time to give a degree of certainty and comfort to the financial world, you are not dealing with the 10 commandments here (or the original 15 according to Mel Brooks). If there is an adverse impact from all or part of the rule, it can be relatively quickly cancelled or amended. We are dealing with new ground here.
Although the legislative process has become especially contentious and bogged down as of late, the administrative process is relatively fast and efficient, and its public and transparent nature (semi-transparent anyway) gives a great deal of opportunity for stakeholders to have an impact on the final outcome.
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They can just cancel Calabria’s cap rule and adopt Watt’s cap rule. That will be fast.
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Tim,
the more I read of Calhoun, the more I feel like I am reading your blog. Have you read the Brookings report he wrote with Ranieri? You seem to be aligned with him on many many fronts, including the GSEs Mission and capital.
Thank you
Michael
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I read the Calhoun-Ranieri paper when it first came out, and plan to read it again soon. (I’m now out on the west coast with my family–and wlll be for the remainder of the week–so am away from the blog more frequently than usual). As I’ve said elsewhere, the great thing about CRL, and Calhoun, is that they know and respect the facts about Fannie and Freddie’s business, and understand the impact the companies have on the cost and availability of mortgages for homebuyers in general and underserved segments in particular. If Calhoun is indeed nominated and confirmed as the next FHFA director, that would be a very welcome development.
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Biden has nominated Alanna McCargo for president of Ginnie Mae. She worked at Fannie Mae.
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Tim,
I recently read the Calhoun-Ranieri paper and thought it was excellent. It is clear that Mr. Calhoun cares deeply about access and affordable housing for all Americans. He also has a very sensible plan for releasing the GSE from conservatorship, once all necessary remaining changes to the institutions are in place.
I did notice one area where he differed from you is in the timing of the forgiveness of the SPS and the liquidation preference. He thought it best to wait until the very end of the process, but in your discussion, you indicate you think it should be done prior to appointing a new director.
I think I see the wisdom of your approach. Once the SPS and liq. preference are forgiven, it will be clear to all participants that these institutions are well on their way to being adequately capitalized. Any remaining changes, such as developing and implementing a new capital rule, would be left to the new director, and made a requirement prior to release from conservatorship. I suspect that would make the political fight over the next director less consequential.
Just wondering if you would be willing to comment on this thought?
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Tim, do you have any thoughts on Michael Calhoun as a potential FHFA director candidate as reported by Gasparino?
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I don’t know Calhoun, but I do know the founder of the Center for Responsible Lending, Martin Eakes, as well as one of its principals, Eric Stein, who spent a couple years as a special assistant to Director Mel Watt at FHFA (and now is back at CRL). Under Eakes and Stein, CRL has done excellent work on the economics of affordable lending. I have to believe that Calhoun has been exposed to that, and if he has, he should have the background that the next Director of FHFA will need as the leader of that agency to switch it from the ideological, fiction-based policies of former Director Calabria to the fact-based ones I discuss in the current post, which will be necessary to move Fannie and Freddie out of their interminable conservatorships and back to where they once again can function effectively as secondary market credit guarantors, while meeting an extremely high standard of taxpayer protection.
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I recall seeing Calhoun in videos over the past few years, and I found him to be a balanced, nuanced thinker. here is a not that dated (2019) video of a Calhoun on a panel, with his spiel (focusing on capital) beginning around 26 minute mark: https://www.c-span.org/video/?461112-3/government-sponsored-enterprises-panel-2
rolg
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I don’t think I’ve seen this video before, but it’s clear from Calhoun’s presentation that he has a very clear and detailed understanding of the role played by capital in the setting of guaranty fees. He also understands which elements of the Calabria capital rule have the largest adverse impact on lower-income borrowers (not counting guaranty fees as offsets to credit losses, and putting capital surcharges on smaller loan sizes and single borrowers), and that the absence of these elements in the FHA’s pricing makes Fannie and Freddie’s affordable housing guaranty fees (unnecessarily) noncompetitive with the FHA.
I liked the way Calhoun started out his discussion, by saying that two-thirds of Fannie and Freddie’s guaranty fee is the “rent” on the capital the companies are required to hold to protect against a repeat of the home price collapse during the financial crisis. (Today, the cost of capital is closer to three-quarters of the fee on an average loan, and much greater for an affordable housing loan.) What he doesn’t say–and I hope this is something he’ll take away from my current post–is that the amount of capital Calabria says the companies need to survive a repeat of the financial crisis is grossly inflated. To lower affordable housing guaranty fees considerably, the next FHFA director merely needs to tie the risk-based capital reserve to the companies’ actual business risk, which can be easily done by running an honest stress test and adding a reasonable (identified) capital cushion. I suspect that if nominated and confirmed as FHFA director, Calhoun would be both able and willing to do that.
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Tim
later on in video, Calhoun addresses the “utility” model of regulation, which I didnt highlight because it appears to me that at this time (2019) he was gravitating towards rather than espousing it, but he seems to have come to espouse it in the Calhoun/Ranieri Brookings article.
the influence of Ranieri on Calhoun is interesting to contemplate…Ranieri was a principal market participant in the RTC S&L real estate bailouts when he was at Solly, and certainly was a preceptive observer if not participant in the GFC bailout (I dont know what role his firm played in GFC, but I can confirm that he was instrumental while at Solly in convincing the RTC to use securitization (at the time, still somewhat novel) as a technique to resolve the S&L mess). So Ranieri provides Calhoun the securities market background and gravitas that has been totally missing from the “GSE reform” conversation. Certainly in their Brookings article, there is a detailed discussion as to how the GSE return on Treasury’s investment dwarfs the return on, for example, Treasury’s investment in AIG.
Simply partnering with Ranieri in that Brookings article sends me a signal that Calhoun is a serious guy who recognizes the capital markets will necessarily be an important tool with respect to ending the conservatorships.
rolg
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Center for Responsible Lending, comment on Calabria’s proposed capital rule (8/31/20)
https://www.fhfa.gov//SupervisionRegulation/Rules/Pages/Comment-Detail.aspx?CommentId=15663
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The progressives are now making a push for Sandra Thompson to be named permanent director ahead of Calhoun. Can’t imagine much would get done under her leadership if that were the case.
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I would be highly surprised if it were “progressives” that are supporting Ms. Thompson as permanent director of FHFA. Much more likely it’s the Financial Establishment, who are concerned that Calhoun would be open to returning Fannie and Freddie to a position of strength in the secondary market, in order to make them effective in providing support to the affordable housing segment. Ms. Thompson is much less likely to depart significantly from the status quo for the companies, which suits the Financial Establishment just fine.
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Is there any substance to this claim by Whalen that Calhoun will kill the GSEs profitability by “eliminating most or all of the LLPAs”?
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This is a unsupported claim made without context or analysis by a known critic of Fannie and Freddie. My advice would be to ignore it.
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A truly excellent article Tim. Very clear and very true. I hope the ones who hold high places read this and have the ability to understand what you are saying. As ROLG said “I can explain it to you but I can’t understand it for you”
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Tim, truly an excellent post. I get it, you get it, most of us here get it. I do have one question though – the big elephant in the room. The financial elitist cabal as I believe you sometimes refer to them. What if this is what they want. What if what they want IS to saddle Fannie and Freddie with so much weight they can never be free. To continue to roll the can down the road…knowing that they can – they’ve proven that. Never to add them to the balance sheet but never to let them free. Who know’s why and for what purpose, however, doing the opposite of what’s clearly in the best interests as you laid out doesn’t necessarily translate to what will be done.
The logic has never been applied that way from the very beginning as you also laid out. It appears that the de facto limbo nationalized (but not nationalized) conservatorship is actually acceptable while they tell us the opposite. No meaningful administration, legislation action or legal decision has otherwise provided any measurable relief. It’s all been to the benefit and timeline of the government. Based on historical actions over the past 14 years there has been no actionable progress to truly get Fannie and Freddie out of conservatorship and to be rehabilitated. That’s my biggest concern right now. The SCOTUS decision really affirmed some pretty terrible opinions about how a conservator can treat the entities which they are tasked with conserving.
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The “big elephant in the room,” as you call it, has been a frequent subject of my posts and comments since I started the blog, now over five and a half years ago. I also wrote a book about it. What I call the Financial Establishment (“financial elitist cabal” isn’t my term) has been trying to restrict or handicap Fannie and Freddie’s business for thirty years, and there is no mystery about its motives: money. The more it can force up the companies’ guaranty fees, the greater the share of the now $13 trillion U.S. residential mortgage market will be financed on-balance sheet by commercial banks, at higher (and more profitable) spreads to their consumer deposits. And for thirty years they’ve used the same strategy: advocating for “bank-like” capital requirements for Fannie and Freddie, without also giving them bank-like asset powers. That allows them to cloak their self-interest in the mantle of safety and soundness, while also crippling Fannie and Freddie’s business. FHFA Director Calabria, who long has been an ideological opponent of the companies, was merely following a well-trodden path.
As I discussed in the current post, however, the takeovers of Fannie and Freddie in 2008 and the subsequent management of them in conservatorship have been based on fictions about their business and their risks. And it’s led to a situation in which two companies that earn over $20 billion per year will be stuck in conservatorship for close to twenty years unless something is done to free them. I don’t believe that’s sustainable. The Financial Establishment has been pretending that something was about to happen to the companies–“they’re about to be replaced in legislation”, then “they’re about to be released”–but now there’s no obvious next stage. The analogy is that Fannie and Freddie are being kept in jail (conservatorship) for a crime (posing enormous risks to the taxpayer) they clearly didn’t commit. How long can the Financial Establishment sustain that? What’s its next move?
The Biden administration is in an ideal position to fix this. Democrats historically have supported Fannie and Freddie, and have seen them as powerful instruments in making housing more accessible and affordable to lower-income Americans. And as I said in my post, by drawing on irrefutable facts it can easily say that the Bush administration made a mistake in its de facto nationalization of Fannie and Freddie, and now–given the state of limbo to which that’s led us–it’s time to rectify that mistake.
Will the Biden economic team take this on? I can’t for certain say it will, but I also can’t see them ignoring such an obvious unsolved problem for three-plus more years, when there is such an easy solution to it.
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The Biden economic team should take on the issue of releasing the GSEs from conservatorship. Your writings have been very clear on the issues and the various approaches to come up with a better solution. The environment is likely the best it can be for releasing the GSEs from conservatorship and as you point out, the solution can be simple.
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And if the Democrats want to do this via new legislation – which is a path that they don’t necessarily need to take – they may only have a short window to do this. But, regardless, they have long wanted to make changes to the GSEs to help the cause of affordable housing and the stars are aligned to do so. But they need to make some decisions in a timely manner. As Redskin coach George Allen used to say – “The future is now.”
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Thanks for the holistic review on this matter, Tim! Very informative and insightful!
I am wondering if you can also share some perspective on that, for big financial firms like Goldman Sachs, Wells Fargo or Warren Buffett, under what kind of scenarios, keeping FnF in conservatorship could be counter-productive to their businesses? I don’t mean name calling here, instead I believe that they are the real driving force behind the conservatorship fiasco. It is inevitably up to them to put an end to this unfinished chapter in US financial history and restore the sanity in this part of the financial world. Therefore, understanding their position may hold the key to a final solution, whatever it may be.
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Wells Fargo is a major mortgage originator and portfolio lender, and was an original member of the anti-Fannie and Freddie lobbying group, FM Watch. I believe they feel they clearly benefit from having the companies tied up in conservatorship. I don’t see either Goldman or Warren Buffet as having that much of a stake in what happens to the companies, and for that reason don’t think they’ll use much if any of their political capital to help them.
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Yet another great article Tim with acute acurate details.. Not even the current set of GSE leaders stand up for the company and justify their numbers, or bogus stories on the stress test, as you do… Probably they are prohibited from self lobbying or self defending themselves i guess. Wish you get to the helm of the GSEs one more time
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Tim, Well done! Please continue to emphasize the greater benefit to homebuyers with a more reasonably capitalized Fannie and Freddie. Your detailed knowledge and presentation skills should be welcomed by all in the Biden administration and Congress in understanding the intricacies of unwinding the conservatorship and bringing this to a conclusion.
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Tim, if you are a resident of MD, you could visit Van Hollen’s office some day. He’s a member of Banking Committee. https://www.vanhollen.senate.gov/contact/scheduling-requests
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I’m not a resident of Maryland, but that’s not a requirement for meeting with a member of the Senate Banking Committee. And while I don’t discuss or disclose my current or planned contacts in the mortgage finance arena, I will say that I’ve met with Senator Van Hollen in the past.
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You’re absolutely right, and I’ll correct the error. (I’ve read many different versions of this post during the lengthy time I’ve had to prepare it, and never caught that.) And I’ll leave your comment up for a while, as a reminder to readers that we all do make mistakes, and appreciate it when others point them out to us.
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Tim, thank you for the excellent summary. The sad irony is we waited for Scotus’ ruling on Collins to, in part, provide Potus the ability to fire the FHFA director at will. Between Layton’s recent article and now your article, pointing out MC withheld the stress test results to push his misguided and delusional capital requirements, in hindsight he could/should have been fired for cause IMO.
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Tim,
Your posts are always rational and informative. Have you seen today’s article in housingwire about FHFA requiring the GSEs to submit annual equity plans? While your approach would make a better case for affordable housing by fixing the incentive structure, what prevents FHFA from forcing “equity” on the companies?
https://www.housingwire.com/articles/fhfa-requires-gses-to-submit-annual-equity-plans/
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Alec–
The “equity” in today’s press release from FHFA doesn’t mean capital; it’s a reference to fair lending. It’s a follow-on to a HUD regulation aimed at reducing discrimination in mortgage origination. FHFA is requiring Fannie and Freddie to “submit Equitable Housing Finance Plans to FHFA by the end of 2021,” and then to update them annually. FHFA wants these plans to “identify and address barriers to sustainable housing opportunities, including the Enterprises’ goals and action plans to advance equity in housing finance for the next three years.”
This may seem cynical, but this is the essence of bureaucratic formalism. If I were still at Fannie, my Equitable Housing Finance Plan would be very brief. I’d start by saying that since we don’t originate mortgages, there isn’t much we can do about discrimination in mortgage lending other than to tell the lenders for whom we guarantee mortgages not to do it. I’d then add that while in the past we’d been able to work with lenders to create innovative special affordable housing products aimed at increasing access for minority borrowers, given the completely ridiculous capital requirements you, our safety and soundness regulator, have saddled us with, we can’t do that any more. My next annual Equitable Housing Plan would say the same thing.
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Tim, great informative post, thank you!
I was wondering if there is any way to quantify exactly how much affordable housing would expand to Americans if the capital requirement were lowered to your proposed 2.5% minimum (or true risk-based standard) vs Calabria’s current 4%+ rule. I believe highlighting the tangible benefits vs a more general statement of its effect (good for home ownership) may be more powerful to policy makers. (Let’s also not forget the TINA warrants monetization benefit for the admin as they can use it to further their administrative agendas to the tune of $50-$100b+).
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If you know the target rate of return you can calculate the impact of a drop in required capital on target guaranty fees, which translates into an equal drop in mortgage rates. For a 10 percent after-tax rate of return, moving from 4.55 percent required capital to 2.50 percent capital would reduce Fannie and Freddie’s target guaranty fees (and mortgage rates) by 25 basis points. Beyond that, though, I don’t know how to estimate how many more borrowers would be able to afford homes were this drop to occur. (I know some economists claim they can estimate it, but I’m not confident they really can.) I wish I could, because I agree it would be a powerful argument.
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Thanks Tim, that claim (mortgage rates would drop 25bps) is potentially a powerful one on its own. It would lead to more affordable homes as the average $300k mortgage monthly savings would be ~$50/month (~$600/yr or ~$18k over the life of the mortgage).
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Tim
If I were lobbying Democrats I would lead with the total savings for lower and middle class homeowners, not how many more would afford homes, if your recommendations were implemented resulting in a 25 bps guaranty fee savings.
for example, for Fannie Mae, it seems to me that Fannie made $1.359T of new conventional single family loan acquisitions in 2020 (10k, p. 90). the incremental per annum cost of these mortgages to homeowners, beyond what a recapitalized and released Fannie Mae would charge for guaranteeing the MBS securities into which these mortgages would be securitized, would be 25bps X $1.359T = $3.3975B…correct?
if you told Democrat legislators and the Biden administration that, if Fannie Mae were recapitalized and released in accordance with your recommendation at the start of 2020, they could have sent an aggregate check of $3.3975B to low and middle class homeowners, would they have signed up for that? Democrats talk about “human infrastructure” but this one change re Fannie Mae would have a huge human infrastructure impact.
rolg
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Excellent post. I hope they get it. Thank you.
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A great post that lays it all out. It’s hard to ignore the facts. I hope it is the catalyst for much needed change.
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Good Post. Hopefully Biden administration changes course.
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Tim
Excellent post!
Every Senator and Representative should reread this sentence:
“For the very long time they would remain in conservatorship, they would have no alternative but to price their credit guarantees to capital requirements that are grossly disproportionate to their credit risk, greatly raising the cost of and restricting the access to homeownership for the low- moderate- and middle-income homebuyers they are chartered to serve.”
Then one should ask them is this what they want? Some might say yes, but the vast majority will say no….and profess ignorance over the fine details of finance. But they no longer have any excuse…you have explained it all for all to understand.
rolg
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Thanks. The intent of the post is to get the facts (and fictions) about Fannie and Freddie’s past and current credit risk on paper. The next step in the process is to get them in front of decision makers in the administration in Congress, which a number of us will be working to do.
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right….and no small next step, indeed.
one of my favorite sayings from an old oil patch wildcatter I once knew is, “I can explain it to you, but I can’t understand it for you”…in the case of Fannie and Freddie, ideology and group-think is always an impediment to understanding, especially in DC and in the realm of finance. but you have taken the necessary first step, laying out the facts for administration/congressional decision makers in order for them to be (gently) confronted by their own misconceptions.
rolg
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Are you implying there needs to be a very simplified summary, perhaps even political cartoon, to motivate decision makers to even consider such compelling facts?
The stigma of wealthy hedge funds getting richer is an unfavorable impression that has surely played a part in decisions to date…
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The financial benefit to “wealthy hedge funds”–and there will be one–gets undue emphasis because of insufficient awareness of and attention paid to the cost imposed on homebuyers by overcapitalizing Fannie and Freddie to make them uncompetitive with portfolio lenders. The latter is far greater in dollar terms, and to senior economic officials in the Biden administration also should be more important.
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